1 Brexit legal consequences for commercial parties Derivatives possible implications April 2016. Issue in focus cleared OTC Derivatives ) may be established in the UK. The UK is important for the global Derivatives markets: Many Derivatives contracts reference, or are settled in, Sterling or UK assets. London is arguably the leading financial centre for OTC Derivatives activity both in the EU Sterling and UK assets are routinely used as and globally. collateral in support of Derivatives trading relationships. Businesses established in the UK use EU. financial services regulation to passport their This article aims to highlight some of the areas in which Derivatives services throughout the EEA.
2 Brexit may impact the Derivatives markets and discusses possible documentation, regulatory and legal Businesses established outside the UK may use implications . However, it is important to note that the a UK passport (for example, by setting up a particular terms of a Brexit and the post-exit model local branch or a subsidiary in the UK) as a negotiated will be central to the ultimate legal analysis way of accessing the UK and/or the broader and the precise impact on Derivatives market EEA Derivatives markets. participants. Consequently, this article cannot be A vast number of OTC Derivatives contracts, regarded as a comprehensive list of all potential issues whether or not involving UK entities, are and their impact.
3 Governed by English law and include a This article is one of a series of specialist Allen & Overy submission to the jurisdiction of the English papers on Brexit. To read these papers as they become courts. available, please visit: Key elements of market infrastructure (for example, central counterparties (CCPs) for Allen & Overy LLP 2016 Brexit possible implications | April 2016. Key considerations and Sterling, a deterioration in the value of those assets will also result in obligations to post additional margin effectively compounding analysis the potential adverse effects noted above. In respect of the possible impact on financial Financial and economic volatility collateral arrangements, please see further below.)
4 Market analysts have raised concerns that the UK. economy may be negatively affected by the increased In respect of each of the above risks, whilst economic, political and legal uncertainty resulting from consideration could be given to the possibility and/or a vote in favour of Brexit or Brexit itself (collectively desirability of hedging against or otherwise mitigating referred to in this article as Brexit) and that this may any perceived risks, in reality, it will be difficult to lead to financial and economic volatility in the UK. assess the precise impact of a Brexit on counterparty credit risk and the value of Sterling and any UK assets If the analysts are right, there are a number of fairly ahead of time.
5 Obvious consequences which could play out in the Derivatives markets: Impact on Derivatives documentation (i) Deterioration in counterparty creditworthiness It is hard to predict (and plan for) the impact of a Brexit on the 1992 and 2002 ISDA Master Agreements as the Businesses with significant exposure to the UK precise impact can only be determined when the form economy could find that their credit rating, or and detail of any post-Brexit regime is known and the their counterparties' view of their true impact on the relevant counterparties is more clearly creditworthiness, is adversely impacted by understood. Brexit. We are not aware of specific Brexit-related termination At best, this would be likely make it more or other provisions being routinely included in standard expensive for those businesses both to enter ISDA documentation either historically or currently.
6 Into new Derivatives (the cost of credit would be There could be some value in carrying out appropriate higher) and to maintain existing positions (for due diligence on ISDA documentation to ensure that example, decline in creditworthiness may lead counterparties are aware of any potentially problematic to new or enhanced collateralisation obligations provisions (for example, any non-standard termination in bilateral OTC Derivatives contracts). rights or any references to specific EU regulation, EU. At worst, the effect could be so significant as to territory and similar terms which would not continue to trigger termination rights whether ratings- have the intended effect following a Brexit).
7 Given the related or arising out of a real default of the current uncertainty, however, counterparties may be credit-impaired counterparty. better advised to wait so that they can focus on assessing the documentation impact when (and if) there is more (ii) Changes in exposures certainty as to the form any Brexit may take. Fluctuations and volatility in relevant markets Equally, there would seem little benefit in amending may create or increase mark-to-market existing documentation (assuming such documentation exposures under existing Derivatives contracts. is standard) until further detail of any Brexit and its This, in turn, would trigger obligations to post impact is known. additional margin.
8 We have given some thought to whether Brexit would (iii) The value of UK-linked collateral could have a material impact on the operation of agreements decline based on the standard ISDA Master Agreements. While Where margin calls are, or have been, met by there may be certain technical amendments required as a posting assets that are linked to the UK (such as result of Brexit (depending, of course, on what form Sterling cash or UK gilts), particularly to cover Brexit takes) and subject to the general caveats regarding exposures measured in currencies other than Allen & Overy LLP 2016 Derivatives possible implications | April 2016. the uncertainty surrounding Brexit, we have not English law is a popular governing law choice identified any major areas of concern.
9 In respect of the ISDA Master Agreement. The reasons for this relate to, amongst other things, Can standard ISDA representations and the certainty, stability and predictability of agreements continue to be made following a English law as well as the commerciality and Brexit? It seems unlikely (assuming that expertise of the English courts: reasons that are current EU and UK laws and regulation unconnected to the UK's relationship with the continue to apply in substantially the same EU. We consider that it is highly unlikely that form) that standard representations and Brexit would substantively impact the agreements would be directly affected by a enforceability of English governing law clauses.
10 Brexit. Consequently, we see no reason why English Are Brexit or the effects of Brexit likely to law would not continue to be an attractive trigger an Event of Default or Termination choice for commercial parties regardless of any Event? We have already discussed the Brexit (both in respect of contractual and non- possibility that adverse effects on the UK contractual obligations). Note that this analysis economy could impair the creditworthiness of applies generally and is not limited to the ISDA. UK-exposed businesses. Although defaults or Master Agreement. For further consideration of credit-related termination events might arise the choice of governing law, please refer to our under ISDA Master Agreements, this is by no specialist paper on this topic, linked here.